There has been a lot of discussion recently about the timing of the incoming recession.The recent inflation reading this week was positive, but seemingly not positive enough to avoid another interest rate increase. Interest rate increases makes borrowing more costly, so fewer economic activities such as loans, investments, and big purchases tend to occur. This in theory should slow down the economy perhaps to the point of recession. As such, the markets to be a bit jittery, and Fed officials continue to forecast a recession later this year or next. At its core, whether there is a recession or not comes down to individuals decisions around spending, and how we choose to spend or save. In the following post which I first posted in 2021, I dive into this, and explain that whether or not there is a recession might depend on how we all feel about the economy, our own economic situations, and how we perceive ourselves. Hope you enjoy!
How does one assess a society? A bit philosophical I know. But if we were to ask a welfare economist they might suggest starting with social welfare functions. Such functions take utility, or vaguely happiness, as an input. Since utility is seemingly difficult to measure, social welfare functions seem to be mostly a theoretical exercise.
But say, you could measure happiness. How to assess a society then depends on your philosophy around which function to use. It could be for example utilitarian, which measures the simple sum of everyones utility, Rawlsian, which takes the minimum of a set of each members utility, or a function proposed by Amartya Sen which uses the Gini coefficient (a measure of inequality.)
If you were to maximize the utilitarian approach, an answer might be to concentrate all the wealth in the hands of one individual who values money the most, but surely this isn’t a great society. Maximizing a Rawlsian function might be great in terms of inequality, where ideally the minimum utility is equal to everyone else, but could be costly in terms of economic growth.
The answer for how to holistically compare societies seems to be elusive. But just because social welfare functions aren’t used directly, doesn’t mean there aren’t proxies. Measures such as life expectancy, income per capita, child mortality rate, literacy rates or education scores might do well to compare societies.
Surely trying to maximize life expectancy, or minimize child mortality is a noble cause and in doing so a social planner might end up with a pretty good society. But is this the only thing we should care about? Arguably the anticipated life expectancy or number of people reading in the surrounding area is a small part of a healthy and literate person’s expected utility. What might be more important for instance, is if they are employed in meaningful work for example, or able to afford essentials like groceries or healthcare. In terms of utility it might be helpful to know if I will have a job tomorrow, as I might be more (or less!) happy knowing so.
This is where economists fill a valuable role. Trying to track, forecast, and help plan for such events like recessions or an overheating economy surely will provide value for those trying to maximize collective utility functions.
How to do that is undoubtedly a challenge. And sometimes the forecasts aren’t great. The reason why is again elusive, I suspect a combination of many factors.
At least, through my education and experience I’ve come to learn the different methods for attempting to accomplish such a goal. Classical, Keynesian, Neoclassical, New Keynesian models try varying approaches, and rely on macroeconomic data like GDP, industrial production, work hours, and CPI to help identify parts of the business cycle, and forecast that next recession.
Using such data is powerful because it avoids the problem of stated vs. revealed preference. The idea is that stated preference might be how people think they are feeling about the economy, but revealed preference is how they actually feel. People ‘vote’ with their dollars essentially, putting their money where their mouth might not necessarily be. So, to get a feel for their happiness, it might make sense to analyze retail spending patterns or durable goods purchases (this is why it was newsworthy this week that retail sales dropped more than than expected.)
However, should the psychology around how people think they feel be avoided? Does that not play a role in their purchasing decision? How does a sense of self and identity impact such spending patterns?
Personally, I struggled initially with how to spend when I first entered the workforce. I was fortunate enough to have a high paying engineering job, not too many expenses, and a good social circle to spend time with. But, I was still in the frame of mind that I was a college kid, and shouldn’t be spending other than the essentials.
Now, a few years removed and in a graduate program, I basically have no income yet I’m spending similar to, if not more than, how I was after I adjusted to spending in my high-paying job.
I suspect that not only your sense of self, but how you think you feel about your finances, identity, and the overall economy matters.
So why not try it?
In this Information Age we have more ability than ever to provide instant feedback. Questions like ‘How was your experience?’ and ‘How was our customer service today?’ are commonplace. Why not “do you feel like you can afford a nice, sit down dinner this weekend?” Even if you have no intention of going out for dinner this weekend, the fact that you feel like you can afford it should indicate some sort of level of general happiness that you believe you are secure financially at least through the week. It’s not perfect, but might be a start. Or what about the University of Michigan consumer sentiment survey? Would that help proxy utility?
One of the basic principles of artificial intelligence models is that you need a feedback mechanism to train the model for its predictions. And here it could apply when generating models on our own, fiscal intelligence, which ultimately manifest in macroeconomic models of the business cycle.
I’ll end with a short story.
A first year economics professor at the local university mentioned in class that they thought there would be a recession in the coming year. The students went home, told their parents, and so each set of parents started saving more in anticipation of the recession. Due to this collective saving instead of spending, local businesses had fewer customers, and some had to layoff or cut hours of their staffs. The fewer hours led to lower incomes for these workers, which, in turn, caused them to cut back on their spending in the local economy. Overall this led to a recession in the local community later that year.